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September 1, 2011

SEC Proposal Fails to Fix Ratings Agencies: Sen. Franken

After Dodd-Frank there have been 'no significant changes in the way ratings agencies operate,' former Moody's managing director says

Sen. Al Franken at a hearing this year. (Photo: AP)

Two of the biggest advocates of credit ratings agency reform warned Thursday that the credit rating agency reform proposals put forth by the Securities and Exchange Commission as part of Dodd-Frank are inadequate, and that the ratings agencies are returning to practices that helped spur the financial meltdown.

The pair—Sen. Al Franken, D-Minn., and Barbara Roper, director of investor protection at the Consumer Federation of America—spoke during a conference call held by Americans for Financial Reform.

“We are talking about an industry that is fundamentally flawed—[in which] issuers pay the agencies to rate their products,” Franken said. The recent proposals by the SEC to reform credit ratings agencies don't "resolve the conflict of interest inherent in the system, which is caused by the ratings shopping,” he said.

However, Franken said that “the SEC still has an opportunity to tackle this problem” by adopting the Dodd-Frank amendment he co-authored, which directs the SEC to create an independent self-regulatory organization to assign the initial credit ratings of securities to one agency.

As Franken noted in a recent commentary on CNN, his amendment “would incentivize and reward excellence. The current pay-for-play model—with its inherent conflict of interest—would be replaced by a pay-for-performance model. This improved market would finally allow smaller ratings agencies to break the Big Three's oligopoly.”

Franken’s amendment was ultimately downgraded to a study in the final bill. Dodd-Frank’s final language, however, requires that the SEC implement Franken’s provision, or a similar alternative, if the agency’s study reveals that the conflicts of interest continue to put investors and the public at risk.

The Big Three ratings agencies, he noted in his CNN commentary, “are well aware that their fates rest, in part, on the outcome of this SEC study, due out next year.” The SEC is accepting comments in advance of the study on the Franken amendment until Sept. 13.

Said Franken on the Thursday call: "[What] I’m waiting for is the study to be completed and once completed, to hold the SEC’s feet to the fire."

Roper (left), of CFA, stated on the conference call that “we’re at a point where decisions can still be made to dramatically change” the way credit ratings agencies operate. While Roper conceded that the SEC is operating under a “very difficult political environment,” she said it’s imperative for the SEC to act, as “we are already seeing a return to the practices [at the ratings agencies] that started the crisis.”

CFA has "a number of concerns about the SEC's rule proposal--the top two being that the agency's provision on internal controls are completely inadequate and that the proposal on conflicts of interest doesn't do anything meaningful to address conflicts," Roper told AdvisorOne. However, the SEC proposal, she added, is "generally quite good on disclosure."

Eric Kolchinsky, a former managing director at Moody’s responsible for rating collateralized debt obligations backed by subprime mortgages, who was also on the call, agreed that post Dodd-Frank, there have been “no significant changes in the way ratings agencies operate.”

Marcus Stanley, policy director of Americans for Financial Reform, quoted on the call the Financial Crisis Inquiry Commission conclusion that the major credit rating agencies such as Moody’s and S&P were “essential cogs in the wheel of financial destruction.”

From 2000 to 2007 the ratings agencies gave their highest Triple-A ratings to tens of thousands of mortgage backed securities—the same securities that triggered the disastrous 2008 crash, Stanley said.

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